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Use of Intellectual Property Audits in the Acquisition and Exploitation of Technology

October 30, 2016

The explosion of technology-based innovations and globalization of the marketplace has heightened the importance of intellectual property in business and credit transactions.  Intellectual property now constitutes a prominent feature of mergers, acquisitions, and security offerings, serves as collateral in credit transactions and is increasingly viewed as a necessary prerequisite for achieving a company's business goals.  Practically every business venture involves some use of intellectual property.  Such usage covers a broad spectrum from the single entrepreneur's use of a web page to advertise its goods and services to the multifaceted usage required of the large pharmaceutical company which has developed a new cancer treatment drug.  Like the physical assets of a business, intellectual property assets have an intrinsic value which generates revenue though licensing or sale agreements, or provides collateral to obtain funding or attract investors.  The identification, protection and exploitation of intellectual property affords better realization of its intrinsic value and significant appreciation of company assets.

Intellectual property audits should be performed by any business seeking to augment or exploit its technology base 

The intellectual property audit is a powerful tool for evaluating and ascribing value to a company's intellectual property assets.  Such audits may proceed a significant technology acquisition or accompany the start-up phase of an affiliate's formation to put into place specific procedures for protecting and perfecting intellectual property developments.  Oftentimes they are initiated during ongoing operations of a company to ensure full exploitation of innovations and protection against infringement claims based on intellectual property rights of others.  They are routinely performed in connection with due diligence investigations during commercial transactions.  In such circumstances, an audit is used to:

(1) determine the origin of intangible assets and the scope of the assets; (2) determine the extent of ownership interests in intellectual property assets, including third party ownership rights; (3) obtain a valuation of intellectual property assets for purposes of licensing or distribution agreements or to assess the viability of a technology acquisition; (4) evaluate and implement internal procedures for identifying, protecting and exploiting intellectual property rights in current or emerging technologies; (5) detect defects in existing intellectual property assets and institute mechanisms for remediation; (6) reduce potential liability from third-party infringement claims arising from use of existing or newly developed products; and (7) assure full valuation for intangible assets in light of changes in intellectual property law.1

Thus, significant benefits are conferred by valuation and appraisal of intellectual property rights as well as the on-going evaluation and management of intellectual property assets. For this reason, intellectual property audits are appropriately carried out during more than one stage of a company's existence, for example, before a significant acquisition of technology or during a company's formation. Advantageously, the intellectual property audit provides a powerful tool through which buyers, owners, and investors of technology assets are enabled to leverage and exploit their intellectual property rights commercially.  

Who performs the audit

The appointment of counsel to perform the audit generally depends on the nature and scope of audit activity.  Occasionally a company's in-house counsel have the background information and technical expertise necessary to conduct the audit.  For large, complex businesses, it is preferable to use an experienced outside intellectual property practitioner having knowledge of auditing procedure and the business technology.  The auditor should have experience with correction of legal defects frequently found in audits.  Also required is the ability to spot issues likely to provoke a subsequent litigation, such as an infringement, acquisition or licensing matter.

Confidentiality of audit results is best protected if the audit is conducted by an intellectual property attorney.  In accordance with this practice, the final audit report is designated to be an attorney work product and becomes an attorney-client communication that is privileged.  The privileged and confidential status of the report excepts it from discovery by third parties.  Conversely, use of a non-attorney intellectual property "guru" will not cloak an audit report with privileged status that protects it against subsequent discovery.

In certain instances, several disciplines should be represented on the audit team.  Where an audit is carried out in connection with a significant technology acquisition, the audit team may include one or more accountants to assist in valuation of the intellectual property assets.  The audit team in that matter may also use an intellectual property paralegal to gather and organize relevant documentation and conduct assignment and title searches.  Indispensable to the audit team in the acquisition matter are the services of an intellectual property attorney or group of attorneys required to interview key personnel, analyze internal and external documentation, design any remedial measures and produce a comprehensive written audit report.  Thus, the audit team, whether composed of a single auditor or a group of auditors is often tailored to address the mixed issues of business, law and technology attending a particular case.

How the audit is performed

In most cases, an audit plan should be drawn up in advance of the audit.  This plan defines the areas and scope of the audit, the schedule, the individuals with responsibility for each phase of the audit, the documents and personnel to be reviewed, and the type of report which will be generated at the end of the audit.

During the audit, the auditors are provided with an overview of the pertinent technology and the industry in which the enterprise conducts business so as to maximize their understanding of the nature and issues involved with the type of audit to be performed.  Technology focused companies generally place a large emphasis on patent and trade secret rights.  Consumer product companies tend to emphasize patent and trademark assets.  Entertainment concerns stress copyright and trademark rights.  The type of business conducted by the enterprise should also be considered.  That is to say, multinational companies may require assessment of foreign intellectual property rights whereas domestic companies need only be concerned with intellectual property rights extent in the country wherein the company resides.  Likewise, statutory rules and regulations, such as package labeling requirements in the food, drug and cosmetic industries should be considered during the course of the intellectual property audit.

The auditors may need access to the business so as to review pertinent documents and discuss various aspects of the audit with key technical and business personnel.  In some cases, provisions are made for the audit to be conducted in secret.  Generally, it is necessary for a confidentiality agreement to be executed before the auditors are given full access to priority company information.

Scope of the intellectual property audit

The scope of the intellectual property audit to be performed typically depends on the nature of the audit and the type of property involved.  Generally stated, the most comprehensive intellectual property audits involve those carried out in connection with business acquisitions, security offerings, significant outside investment opportunities and company formation.  Intellectual property audits that are frequently less extensive involve financing transactions or on-going intellectual property assessments.  A buyer contemplating an acquisition of substantially all of the assets of a business should conduct a comprehensive audit, covering all of the intellectual property assets of the seller.  The buyer should investigate the types and extent of intellectual property protection (e.g. patent, trademark, copyright and trade secret) for any products or processes utilized or marketed by the seller and the extent of any third party rights in these assets, and whether the seller's products or processes infringe the intellectual property rights of a third party.

In cases where a comprehensive audit is required, for example, prior to a significant asset acquisition, the buyer's audit team should consider the following information:

  • Interviews with technical and business personnel;
  • Seller's policies and procedures for documenting, disclosing and protecting inventions, selection and adoption of trademarks, and acquisition of creative materials; and marketing plans with respect to the foregoing (including any internal strategy information)
  • A complete listing of all material inventions, trademarks or copyrights; including a complete listing of all authorized and unauthorized software utilized on company computers;
  • Third party agreements relating to ownership or encumbrances of inventions, trademarks, or creative materials;
  • All contracts including license and maintenance agreements, assignments, research and development agreements, distribution and manufacturing agreements, nondisclosure and confidentiality agreements, employee and/or consultant agreements including termination agreements, if any;
  • All domestic and foreign applications, registration and recordation documents (e.g. for patent, trademark and copyright applications and/or registrations) including the full files for each as well as any uniform commercial code filings; especially all pending patent applications, and a listing of any proposed patent applications;
  • Any opinions regarding the patentability or registerability of inventions, or trademarks or creative materials, respectively;
  • The results of any infringement searches, as for example, to determine the right to practice a particular invention;
  • Any opinions regarding the infringement of any third party patent, trademark or copyright rights, as well as any infringement avoidability procedures;
  • Claims of patent, trademark and copyright infringement against the seller, including a review of insurance coverage for such claim, if any exists;
  • Publication and/or trade show disclosure regarding the source of the audit;
  • Patent, trademark or copyright indemnification; and
  • Seller's product packaging, labeling and marking procedures and regulatory compliance.

A number of external sources may be consulted as well. These include:

  • Assignment searches to identify relevant patents of the seller's competitors;
  • Patentee searches to ascertain whether any patents have been issued to seller's employees and not yet assigned to seller;
  • Title searches to determine ownership, licenses (exclusive and nonexclusive) and security interests in any of seller's patents, trademarks and copyrights;
  • Search of various commercial databases for state registration and common-law trademark usage;
  • Review of opposition and/or cancellation files of trademarks which are similar to seller's; and
  • Customs recordations.

Additionally, if any trade secrets are held by the seller, the following information should be obtained:

  • Seller's policies and procedures for maintaining sensitive information in confidence, as well as seller's policies and procedures for receiving outside submissions of confidential information;
  • Lists of trade secrets;
  • Hiring and exit interview of technology personnel including confidentiality obligations set forth in employee agreements;
  • Confidentiality and/or nondisclosure and non-analysis agreements; and
  • Security procedures pertaining to trade secret information (i.e. restrictions on plant access and document control).

The foregoing information should enable the auditor to uncover any areas which need remedy, for example, by federal and state filings to protect new technologies, trademark and copyright registrations to effect renewal, payment of maintenance fees for issued patents or affidavits for continued use of trademarks, recordation of assignments, exclusive licenses, and filings to perfect security interests.  Likewise, the audit may reveal defects in title to certain intellectual property assets which need remedy, including joint ownership claims by third parties.  Most importantly, the audit may reveal potential infringement of third party rights, necessitating negotiation of licensing arrangements in order to avoid any such infringement claims.


After the audit is conducted, a written report should be generated if the circumstances are such that the written report will be privileged and not discoverable.  In general,  the report should contain information pertaining to the particular industry and/or technology, the intellectual property assets scrutinized, defects found, if any, and any remedial action necessary in order to correct such defects, as well as any other information that may be pertinent to the type of intellectual property audit conducted.  In the instance where an audit has been commissioned in view of an acquisition, merger, security offering or the like, the audit report should contain a valuation of the intellectual property assets.

Leveraging the results of the audit

Information developed by the intellectual property audit provides the audited company with a basis for determining whether assets should be protected or sold, held as a source of revenue through licensing or other transactions, or kept indefinitely as trade secrets.  In certain instances, an audit will enable a buyer to better understand the extent of intellectual property rights held by the seller in relation to those appointed for sale.  Conversely, the audit may enable a seller to remedy defects in its intellectual property and thereby extract a significantly higher purchase price.  In our increasingly global marketplace, intellectual property audits have become an indispensable tool, available for use by virtually any enterprise.  The value-added components of these audits are beneficial to a broad spectrum of business concerns, ranging from mom and  pop operations seeking to acquire name recognition, to diversified high technology conglomerates seeking to cement and further exploit their share of the global marketplace.  It is therefore important that enterprises consider the intellectual property audit as a vehicle well suited to promote the identification, protection and exploitation of their intellectual property rights.


1For example, in State Street Bank & Trust Co. v. Signature Financial Group, Inc., No. 96-1327 (Fed. Cir. July 23, 1998), the Court of Appeals for the Federal Circuit recently ruled that business methods may be patentable so long as they produce a useful, tangible and concrete result. See e.g. Ernest D. Buff et al., Protection and Exploitation of Financial Services Software, 153 N.J.L.J. 1252 (Sept. 21, 1998). Thus, intellectual property audits may now be appropriate for those enterprises having economically significant business methods.

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